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What is Prepaid College and Is It a Good Idea?

What is Prepaid Tuition?

Education

What is Prepaid College and Is It a Good Idea?

For many of us, we think that the only time to pay for college is that the beginning of each semester.  Some states, offer prepaid college tuition plans with the intent of saving you money by hedging against unknown, future tuition increases. Locking in a tuition rate can save you money, but, is it a good idea.

What is Prepaid Tuition?

Prepaid tuition is exactly as it appears. Instead of dipping into a 529 plan, savings account, or applying for a student loan right before the next college semester starts, you pay the tuition costs several years before your child becomes a college student.

The idea is that you can save money by paying a lower tuition rate by predicting how much the future tuition rate per credit hour will be. For example, the current tuition rate might be $371. Based on when your child is scheduled to begin college, the prepaid college tuition plan might charge $450 per credit hour.

For the example, you save money when the actual rate is higher than $450.

You lose money if the actual rate is lower than $450.

In some ways, you might think of prepaid tuition as a gamble because you are hedging against future tuition hikes that are larger than predicted. As college could cost $500,000 in the future, prepaid plans can make financial sense if you have the money available now to make the payments.

It’s also important to note that prepaid plans can actually be cheaper if you wait until your child is closer to graduating high school. Like predicting short-term interest rates, tuition rates for the immediate future are easier to predict than when your child is just beginning kindergarten. Your state might unexpectedly freeze tuition rates for a few years and these wouldn’t have been accounted for in earlier predictions.

How Many States Offer Prepaid Tuition?

There are currently 11 states that offer prepaid tuition plans. Several more states used to offer similars plans and have discontinued enrollment from 2002 to 2013.

These are the following states that currently offer prepaid tuition plans:

As most of these states have a state income tax, contributions can grow tax-free for federal and state income taxes when the funds are used for eligible college expenses.

How to Signup for Prepaid Tuition

Each state has diffrent enrollment requirements. Like healthcare enrollment that is only open to switching plans penalty-free in the final months of each year, you must wait for enrollment season to enroll in a prepaid tuition plan.

Most state plans open enrollment in the fall month months of September through November. Although, you need to check with your state to be sure.

How Do You Pay for Prepaid Tuition?

Once you are enrolled, you have several different payment options. Most plans allow you to purchase one academic year, all four years, or for a single semester. Florida even allows you to prepay dormitory expenses.

Some states offer more plans than others and some are more flexible with receiving payments. Certain plans might require a lump-sum payment to be made during the current academic year. Others allow you to make a monthly payment during the year or until your child graduates high school.

While prepaying college tuition is a large expense, it’s nice to have options if you cannot afford to prepay every single year or if you need a monthly payment plan to afford the tuition.

Using Prepaid Tuition

Once you have made the prepayment, your child generally has 10 years to use the tuition from the anticipated enrollment date. Each state might have different requirements.

Prepaid tuition is generally accepted at most public two-year or four-year universities within the state for undergraduate and graduate degrees. And, some private schools will also accept prepaid dollars although you might still have to pay the tuition difference as private schools generally cost more per credit hour than public schools without factoring in financial aid.

Any remaining money can be refunded or transferred to another prepaid account for another child you have attending college.

What If I Move Out of State?

If you move out of state, you can still use your prepaid tuition for schools within the state. Some plans (i.e. Florida) will even consider your child an in-state resident still. Other states, like Virginia, will still require your child to pay the difference between the in-state and out-of-state rate if they attend a Virginia school.

Some state plans allow you to use your prepaid dollars at an out-of-state school. You will need to read the policy before enrolling if you expect to move before your children will graduate from college.

You also have the option to cash out your prepaid plan and be refunded your contribution. This can be a viable option if your child decides not to attend college and you cannot transfer it to another prepaid account. As the contributions might not be used for college expenses, you might be charged taxes on the withdrawal amount.

Advantages of Prepaid Tuition

These are some reasons to consider Prepaid Tuition

  • You don’t have to prepay all four years
  • Protects against future tuition inflation
  • Prevents having to borrow future student loan dollars
  • Contributions are tax-free
  • Can be used for gradaute school
  • Can be transferred to another sibling

States also like prepaid tuition plans because they

Disadvantages of Prepaid Tuition

And here are a few reasons to avoid prepaid tuition:

  • Tuition might not rise as quickly as anticipated
  • Your child might decide not to attend college
  • If you move out-of-state, you might not use the funds
  • You child may get a better offer at an out-of-state college and not use the funds
  • You or a family member needs to be an in-state resident to qualify
  • Limited enrollment periods

Alternatives to Prepaid Tuition Plans

Prepaid tuition isn’t the only way to save for college and not borrow money.

529 Plans

A more effective way might be investing in a 529 College Savings Plan that invests in mutual funds that earn interest. They might not outpace tuition inflation, but, you can open a 529 at any time during the year and make contributions of any amount.

529 plans can be used at any public or private college in the nation. If you move states or your child decides to attend college in Hawaii when you live in Virginia, your contributions can still be used.

In addition to being accepted anywhere, 529 plan contributions also grow tax-free and can be transferred to another child if necessary.

Coverdell Accounts

Also known as an “education IRA,” Coverdell education savings accounts let you contribute up to $2,000 tax-free each year for future college expenses. Contributions are self-directed and can also be invested in stocks or ETFs.  This means you can get a potentially higher rate of return compared to a mutual fund. Just don’t be reckless.

High-Yield Savings Account

A third option is to put money in an online savings account that earns interest. This is the “most expensive” option.  The interest is taxable and you will only earn about 1% at best at most online banks. But, your money is liquid and can be used at any time.  A penny saved is still better than having to borrow a penny later because it was spent on something else instead.

Summary

Prepaid tuition can be a good option to pay for college.  If you already have money set aside and want to hedge against tuition inflation this is the route to take. Unfortunately, we can’t predict the future and you might have to move out-of-state or your child might decide to attend school out-of-state. To protect against the professional and educational unknowns, it still might be better to go with a tax-free 529 savings plan that can be used at nearly any college in the U.S.

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